HP, Oracle, Apple: Canaries in a mineshaft

Rob Enderle, 17th August 2010

Over the last several weeks we have seen serious problems at HP, Oracle and Apple that are potentially indicative of bigger problems cutting across corporations and potentially going far beyond the technology industry.

For HP it was the removal of a CEO for ethical violations and the increasing information that suggests his excessive focus on personal compensation and bottom line performance was killing the company he was previously praised for managing.

For Oracle it is the charge of fraud from the US government which is tied to practices that may not only be widespread in that company but across the industry and potentially lead to the financial collapse of a number of companies.

In other words, if it can happen at Apple it likely is happening much more broadly in other firms.

Let’s explore each after setting the stage.

Canary in a Coalmine

Canaries were used in coalmines, and evidently still are, to identify toxic odorless gas that may creep up and kill miners. If the canaries stop stinging and fall then there is a problem and the miners may have only moments to get out of the mine before they could potentially die. One hopes that someone grabbed the canaries on the way out.

In business there are few reliable early warning systems, certainly with the financial attack there were indications that the housing market was failing and we had a very capable and vocal whistle blower warning about Bernie Madoff before his company failed but the majority of politicians, investors, and executives ignored the signals and the world dropped into an economic crisis that has no parallel in most of our lives.

But when failures do begin to become visible they tend to be discovered, not globally initially, but in one company and then, as folks begin to look at other firms, the depth of the problems become vastly more visible. Let’s explore why the problems at HP, Oracle, and Apple may be indicative of broader issues in the market.

HP: Sex, Money, and Wall Street

There is so much to this story from an alleged affair that was both paid for by the company to its cover up and falsified expense reports to deeper issues that have not been as widely discussed. But underneath it all was the excessive compensation paid to the CEO and the massive drop in employee morale. The overarching problem has emerged as a CEO who was both loved by Wall Street and effectively being paid a ton of money to destroy his company.

This goes beyond governance to the focus that Wall Street puts on the bottom line and lack of focus they put on other sustaining aspects of the business. This same focus is at the heart of the housing market crash where high flying firms were praised while taking unacceptable risks and, after the crash, it is very hard to find more than a few scapegoats that were held accountable for what was a broad failure in most aspects of good business practices.

HP was founded to be a company that cared for its employees, invested in its future, and preserved its integrity yet it has now had two CEOs in a row who were designed to meet Wall Street’s needs and both severely were fired for not doing the job that needed to be done.

In looking back at Mark Hurd, he entered the company as a CEO that was connected to his employees and had actually moved into a cubicle at NCR where he was not excessively paid. At HP his perks, power and money tied to making decisions that harmed the long term strength of the company by undermining employee loyalty and pretty much repeating many of Carly Fiorina’s mistakes including taking on the Chairman position on the board.

But from illicit affairs which often seem to be an executive perk in some industries to an excessive focus on quarterly results the core problems are hardly unique to HP and suggest that others like this are only waiting to be found. Perhaps that is the real reason behind Larry Ellison’s letter to the New York Times, it may have been intended for Oracle’s board not HP’s.

Oracle: Fraud Squared

Government contracts ranging from local, to national, and international contain clauses that require the firms serving them give them a price equal to their best. These clauses are called "Most Favored Nations" clauses and they are a nightmare waiting to happen and Oracle is in the middle of this nightmare. But Oracle’s problem is likely not limited to the US Federal Government nor is the problem likely just limited to Oracle.

The incentives, bid process, and review structure at companies like Oracle that serve governments are directly opposed to assuring that the conditions in these clauses are met. Incentives tend to favor the profitability of the deal not the accuracy of the management of the contract. This tends to put a lot of focus on having a winning bid but not a lot on making sure the bid is as low as any others. In addition, bids tend to be both complex and unique making it very difficult to compare one, apples to apples, to another.

Finally, those that oversee the contracts are generally focused on making sure that the government is paying for everything they contracted for and more, not whether the government is paying too much. That is generally left up to government review but those reviews can’t possible look at the massive number of contracts nor are the reviewers, generally, experienced enough with every unique vendor pricing method to come to a timely decision.

In short, there are likely a huge number of government and large enterprise contracts that have these clauses that are in default and could even be fraudulent but they are sitting waiting to be discovered. This is why you’ll likely see Oracle move aggressively to settle out of court so that discovery doesn’t identify the broader problem which, with penalties, could put Oracle in severe financial distress.

But, Oracle would only be the first to fall and, once a litigation and investigation team was in place coupled with substantial need for additional revenue and cost cutting by governments everywhere and this could be only the tip of an ugly iceberg.

Apple: iTheft

Apple may be a lot of things but poorly controlled it is not. Jobs is known for having no sense of humor when it comes to excess costs or theft and you would think Apple would be on a list of companies unlikely to experience internal bribery as a result. However, Apple, like most companies in tech, has increasingly used suppliers and labor from geographies where bribes and graft are part of the culture so it shouldn't be surprise that one of Apple’s employees decided to cut himself a big piece of Apple’s financial pie.

But if this can happen at Apple, and this may not be the only person doing this there, it could likely happen to any firm and this kind of self-dealing is incredibly difficult to catch even by experienced teams.

For example, when I was running one we identified the potential for a similar problem and suggested process changes only to discover that our sample hadn’t actually picked up that it was ongoing when we did the audit. Since then audit teams have been drastically reduced in both staff and funding making it likely that this kind of behavior is wide spread both in and out of the technology segment leading to higher costs, lower margins, and a slower recovery.

While at least this one doesn’t put Steve Jobs or Apple at risk of failure who knows how much money is truly being lost to ever more creative and as yet undiscovered financial crimes in a variety of companies.

Wrapping Up: The Beginning of Another Collapse?

I certainly hope not but these problems are likely small indicators of bigger issues waiting to surprise companies from practices that likely should have been revisited sooner than this. From an excessive focus on short term costs, sex as a common perk (there are actually services for this, and I'm guessing Mark Hurd may have wished he'd used one), and nearly no focus on the long term health of companies by those analyzing them, to a system that breeds government and large enterprise fraud, to inadequate controls in world where some cultures reward criminals we may be seeing the beginning of some really shocking and expensive revelations.

One wonders how many of them will go on behind the scenes until the market becomes aware of this tend the wheels come off the cart.

Canaries serve a purpose, ignore them at your peril, and HP, Oracle and Apple may be those canaries.

Rob Enderle is one of the last Inquiry Analysts. Inquiry Analysts are paid to stay up to date on current events and identify trends and either explain the trends or make suggestions, tactical and strategic, on how to best take advantage of them. Currently, he provides his services to most of the major technology and media companies. The opinions expressed in this commentary are solely those of the writer.